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Choosing Equity As The Most Favorable Asset Class

Choosing Equity As The Most Favorable Asset Class

As we have seen various asset classes like Equity, Debt, Commodity in the previous article, we would want to share our recommendation here. We, at The Capitalist, would recommend investing in Equities for several reasons: For investing in equities, we need to first understand about equities.

Let’s go deep into the concept of EQUITY!

Equity

Equity also known as Stocks or shares, represent ownership rights in the listed company. When an investor invests in the company equity, he owns stocks of that company and has ownership rights of that company. He is then called a shareholder of that company.

Equities are most widely used asset class by the investor community. The reason is that you get higher returns from this asset class. Indian Equity market being the emerging market has lots of scope for growth in near-term. Generally based on technical and fundamental analysis, an analyst gives recommendations to its clients, and invest in the stocks based on their investment horizon & risk tolerance.

In equity markets, be it direct equity, ETF, equity derivative product or Mutual funds, it’s better to build up your portfolio in such a way that the risk and return are balanced. Equity is diversified into Large Cap, Mid Cap, Small Cap/ Penny Stocks based on Market Capitalisation.

A derivate is a contract which derives its value from an underlying asset. Equity derivative is a contract which derives its value from its respective equity script.


Derivatives are divided into 4 products:

1. Forward Contract

2. Futures contract

3. Options

4. Swaps

Drivers of Equity market

Indian Equity market is driven by demand and supply forces in the market by institutions like banks, Mutual funds, Pension funds, financial Institutions etc, retail Investors (ordinary public), High Net Worth Individuals, FII’S, DII’S and promoters.

The main drivers to drive equity market are: equity

  1. Inflation: One of the major contribution for equity markets. Technically it has an inverse correlation with valuation. (low inflation drives high multiples and high inflation drives low multiples). Deflation, on the other hand, is bad for stocks as it signifies the loss of purchasing power.
 
    1. Interest Rates: Interest rates depends on inflation. High inflation would lead to high-interest rates set by RBI which would make the cost of borrowing high for the companies. High borrowing cost would make companies pay more financing cost which would affect the profitability of the business. Lower interest rates would benefit the companies which would help them in getting sustained in the market as there will be very little or no cost of borrowing.
 
  1. Earnings: Earnings of the company is also an indicator stating that purchases at lower prices and high sales would lead to higher turnover and margins and higher margins would lead the company to make higher profits, thereby increasing the market capitalisation. This would lead the stock prices to move up.
 
  1. Dividends: Many Investors invests thinking that they would get good dividends at the end of the year. Good dividend payout ratio would attract more investors to invest in the company.
 

Types of returns:

There are two types of returns you can expect from equities:

  1. Capital Gains: For Example, if you buy ABC Ltd stock at Current Market Price of Rs.100/-, after one year its price appreciates to Rs.110/- and if you sell the stock you would earn Rs.10/-per stock you hold (110-100 = 10, 10*number of shares).

  2. Dividends- Investor can receive returns in the form of cash dividend or stock dividend. Stock dividends are basically bonus issue.

Conclusion

Equity is the most prominent asset class used across countries. Being a risky asset class, it also gives huge returns, as it works on compounding theory. This theory gives you the best results when you start early. A stock market is a liquidity driven market as you can enter and exit the market whenever you want. It does not have a lock in period and minimum investment criteria unlike fixed income products or some of the mutual fund products.

Also comparing with other asset classes with percentage growth wise, equities would deliver around 12% - 15% against 6% - 7% growth from Fixed income products or debt products.

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